THE ECONOMICS OF CLIMATE

CHANGE – THE STERN REVIEW

Jill Green

• Climate change predictions

• Methods of modelling of impacts

• Results for business as usual (BAU)

• Results with stabilisation

• Social cost of carbon

• Criticisms of methods/assumptions

• Discussion

The Stern Review

FAQ 2.1, Figure 1

The atmospheric concentration of CO2 is currently at about 382ppm. It is increasing by

around 2ppm per year. Including other GHGs (ie. methane, nitrous oxide etc) the

atmospheric concentration of CO2-e is currently at about 430ppm. It is increasing by

around 2.5ppm per year. Source IPCC

Current levels of the main GHGs

Projected Changes in Global Average Temperature

to 2100 under Different IPCC Emissions Scenarios

(highest – A1FI, lowest – B1)

Inertia in emissions impacts

Predictions of Temperature Increases

Types of analysis undertaken

1. Descriptive (disaggregated)

techniques

2. Economic models of costs of:

– Business as usual (BAU)

– Emissions reduction

– Adaptation

3. Social cost of carbon (or CO2)

1. Disaggregated Techniques

Insurance capital requirements

Source: Association of British Insurers, 2005

2. Economic models - scope

• Most comprehensive study so far

• Timescale more than 200 years

• Stochastic allowance for uncertainty

• Covers market and non-market impacts

and risks from extreme weather events.

• Additional dynamic feedbacks

Possible Range of impacts

Global loss of income from climate change Source: Stern Review

Valuation assumptions

• Consumption without climate change grows by g, population by 0.6% pa to 2200 then stable

• Climate change impacts on incomes are projected stochastically (1,000 model runs)

• Consumption paths converted to utilities (measure of welfare)

• Ut = Ct1-η /(1-η ), if η =1, Ut = ln(Ct)

• η is elasticity of marginal utility, set η =1

Valuation assumptions cont’d

• Pure time preference rate, δ (0.1% pa)

– no discount of welfare of future generations

– chance of extinction

• Shadow discount rate = δ + η * g

- growth (g) initially 2% pa (developed),

4% pa (Asia), reduces to 1.3% pa in long term

- long term shadow discount rate is 1.4% pa.

Valuation method

• How much consumption would be given up now to get the same total stream of utilities

Illustration of Consumption Comparisons

2005

2055

2105

2155

2205

No climate change

Business as usual

Balanced growth

equivalent

Business as usual results

• Losses in per capita consumption “now and forever”

Scenario Balanced growth equivalent (%)

Climate Economic Mean 5th percentile 95th

percentile

Baseline Market

impacts

2.1 0.3 5.9

Market +

catastrophe

5.0 0.6 12.3

Market+cat+

non-market

10.9 2.2 27.4

High climate Market+cat+

non-market

14.4 2.7 32.6

Increase in global temperature (relative to pre-industrial

levels) for different stabilisation levels (expressed as CO2

equivalent).

Temperature change by 2100

(relative to pre-industrial)

Temperature change at

equilibrium (relative to pre-

industrial)

Stabilisation

Level

(CO2

equivalent)

Temperature

change -

based on

IPCC 2001

climate models

Temperature

change - based

on 2004 Hadley

Centre

ensembles

Temperature

change -

based on IPCC

2001 climate

models

Temperature

change -

based on 2004

Hadley Centre

ensembles

400ppm

1.2 - 2.5C

1.6 - 2.8C

0.8 - 2.4C

1.3 - 2.8C

450ppm

1.3 - 2.7C

1.8 - 3.0C

1.0 - 3.1C

1.7 - 3.7C

550ppm

1.5 - 3.2C

2.2 - 3.6C

1.5 - 4.4C

2.4 - 5.3C

Source: Based on den Elzen and Meinhausen (2005). From Stern Review

Source: http://www.hm-treasury.gov.uk/media/9/1/Chapter_8_The_Challenge_of_Stabilisation.pdf

BAU emissions and stabilisation trajectories

Costs of emissions reduction

• Meta-analysis of model simulations

• To stabilise concentrations at 550ppm over period to 2100 is

– Average cost 1.0% pa gross world product

– Range of costs –2% (gains) to 5% GWP

• Similar to costs estimated for Australia by Allen Consulting for the Business Roundtable on CC

• Climate change cost still 1.1% “now and forever”

• Therefore, 1% cost of abatement measures will reduce cost from 10.9% to 1% of consumption “now and forever”

3. Social Cost of Carbon

• Value at a point in time of the future losses in welfare caused by the emission of one additional tonne of CO2

• Result dependent on assumed future path of emissions, current concentration, discount rate, etc

• Used to compare with cost of abatement (emission permit prices)

• If SCC is higher than abatement cost then economically positive to invest in abatement

• Provides a bottom up assessment of costs/benefits of emissions reduction

SCC results

• Stern has calculated current cost of

$US85 per tonne CO2e under BAU

• Compared with cost of $US30 per tonne

under stabilisation at 550 ppm CO2e

• Results are dependent on assumptions

so other calculations (eg W. Nordhaus)

are much lower - a source of criticisms

Criticisms of assumptions

• High proportion of costs relate to post 2200

• Imply a very high rate of saving (or early

investment in abatement measures)

• Better to invest in improving developing

economies than in climate change action (or

pay compensation in future for damages!)

• BUT will delay of action increase risk of

severe & irreversible damages?

Some results of sensitivity testing • Changes in Baseline cost of 10.9% now and

forever

– If δ = 1%, cost reduces to 4%

– If η = 2, cost reduces to 3.4%

– If results weighted by population instead of

income, cost increases by 25% or more

– If assume greater convexity of damage

function, cost increases to 14.2%

• Brad DeLong (Prof. of Economics, U.C. Berkeley) “investments in controlling global warming are not risk-increasing but risk-

reducing ones; they are more like buying insurance than like speculating

on unproven technologies. The appropriate hurdle rate is thus lower, not

higher, than for sure things”.

• Stern Review report “In many ways, the science has progressed further than the economics”

• John Quiggin (Prof. of Economics, Uni of Qld) “Economists can help to define the issues, but it is unlikely that

economics can provide the final answer”

Quotations

Economic Modelling in Australia

There are a number of parties that model the economic impacts of

climate change in Australia. These include:

• ABARE

• Treasury (for the government)

• Professor Ross Garnaut (for the Labor party) The Review will examine the impacts of climate change on the Australian

economy, and recommend medium to long-term policies and policy frameworks to improve the prospects for sustainable prosperity. It will draw upon the significant expertise within Australia on climate change matters and place Australian policy in an international context. His web site says where appropriate, he will also be seeking submissions on specialist subject areas.

He plans to hold a public forum in Sydney during Oct/Nov 2007 on Financial services and climate change

• Business Roundtable on Climate Change (Allen Consulting)

Questions / Comments / Ideas?

• Opportunities for actuaries

– Insurance

– Risk management

– Design/management of trading schemes

– Adaptation strategies